United Kingdom: Further weakening ahead
Economic conditions have deteriorated markedly and forward-looking indicators suggest a further sharp weakening in activity over the next quarters. The adjustment in the construction sector is expected to continue, while house prices are likely to fall further. These factors, combined with turmoil in the banking and financial sectors, are already cutting domestic demand. Growth may resume only in late 2009. Unemployment is set to rise rapidly, but should stabilise in 2010. Inflation should recede, reflecting the recent falls in energy and food prices and the increasing output gap.
Given the dramatically weaker outlook and signs that inflation expectations are now declining, the Bank of England should continue to cut its policy rate rapidly, particularly because fiscal policy is constrained by the weak budgetary position. The fiscal rules are likely to be reformulated; it is important to set out a credible plan for putting the public finances on a sound footing as soon as the economy recovers. The comprehensive plan to restore confidence in financial markets is welcome.